Obama flinches on the fiscal cliff

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Heading into the holidays, most people in Washington expected President Obama to hold firm against Republican obstinacy and let the country go over the fiscal cliff. Obama had been handily reelected after campaigning to raise taxes on households making more than $250,000. Afterward, he kept campaigning. He didn’t just want to raise taxes. He also wanted to cut entitlement programs and resolve the upcoming budget deadlines that are sure to upset consumer confidence and slow the recovery. Right up until the end, Obama was admonishing Republicans to go along or face the consequences. Then he folded.

Even before the deal was settled, many liberals were outraged at how much he was willing to concede to avoid going over the cliff — an event for which every poll showed Republicans would be blamed. Most Republicans were terrified at the prospect.

Nonetheless, Obama agreed to raise income tax rates only on households making $450,000 or more; establish a generous inheritance tax exemption; and lightly tax dividends and capital gains. The income-tax threshold alone sacrifices $200 billion compared with what he had once insisted on. But the revenue sacrificed isn’t terribly important.

What is important is that Obama yielded on resolving the budget deadlines, the most consequential being the need to raise the debt limit. Already, Republicans are threatening default without deep cuts in return. Had Obama been willing to go over the cliff, they probably wouldn’t be, since the public would be furiously blaming them. By pulling back, Obama passed up a chance to “break the fever” (as he likes to put it) that afflicts the Republican Party and led it to oppose nearly all that he has done during his presidency.

The great unsettled debate among partisans over the last four years is whether, in the event of some ultimate confrontation, Americans would side with Democrats or Republicans. This debate first climaxed in the weeks before the continuing resolution that funds the federal government was set to expire in April 2011.

That prompted a furious showdown between Obama and House Republicans, just swept into power by the Tea Party in the midterm elections. But rather than let the government shut down, as partisans on both sides wanted, Obama and House Speaker John Boehner cut a midnight deal that satisfied no one. Democrats blamed Obama for capitulating to the Tea Party by agreeing to $40 billion in cuts, rather than let Republicans get blamed for a shutdown. Republicans thought those cuts were gimmicks and believed that a country that had just unleashed a Tea Party wave on Washington would rally behind them after a shutdown.

Unresolved, the debate intensified over the summer as the debt limit approached. To avoid a catastrophic default, Obama and Boehner struck another last-minute deal that satisfied no one. Democrats were furious that it cut $1 trillion and didn’t raise taxes. Republicans were upset that the cuts weren’t immediate and feared they would never happen.

Traditionally, presidential elections settle these kinds of debates.

Obviously, this one didn’t. Going over the cliff might finally have done the trick. If Americans concluded that the GOP had forced huge tax increases on everyone because Obama was trying to raise tax rates on the wealthy, the backlash would have been ferocious — possibly enough to get a debt limit increase folded into a deal, but certainly enough so that turning around and threatening default would be untenable.

Obama characteristically chose the risk-averse path, so we’ll never know for sure. But there’s good reason to think this was his chance to break the fever without risking a meltdown, because Republicans were in a similar position once before and lost badly. Just over a year ago, House Republicans tried to block the extension of the payroll tax holiday, awkwardly opposing a middle-class tax cut. The condemnation, including from fellow Republicans, was so severe that they quickly folded. Given the scope of the tax increase in the fiscal cliff, that reaction would have been amplified severalfold.

Instead, Obama relented, thereby setting up a triple-threat showdown that dwarfs the cliff. Two months from now, the debt limit, the expiration of the continuing resolution, and the automatic spending cuts known as “sequestration” all kick in at once.

Obama has chosen to keep navigating the same minefield as before in pursuit of a comprehensive deal. It’s a different strategy than was employed by the last Democratic president to strike a big budget deal. In 1995, Bill Clinton stared down Newt Gingrich and let the government shut down. Two years later, the fever having broken, the two signed an accord that ultimately balanced the budget.

Joshua Green is a national correspondent for Bloomberg Businessweek. Follow him on Twitter @JoshuaGreen.